Friday, November 28, 2014

With the price of oil
hitting levels not seen for more than four years, it's becoming an increasingly
important issue for investors who are long on oil company shares, particularly
given that some of the resource plays currently in vogue require prices that
are far higher than conventional plays to provide a positive return on
investment. As you will see in this posting, this is particularly true
for Canada's oil sands operators and companies operating in the American shale
oil region. In this posting, I will look at three different analyses
that, in combination, give us some sense of the headwinds facing the oil
industry.

Back in mid-2014, Reuters and Natixis published a brief article
on the break-even price of producing an additional barrel of oil by geographic
region, including both ethanol and biodiesel. Here is a summary of their analysis:

The marginal cost of producing an additional barrel of oil from the Canadian oil sands is between $89 and $96 per barrel compared to $70 to $77 per barrel for U.S.-based shale oil.

Here is another analysis by the Carbon Tracker
Initiative showing the break-even price for the top twenty largest oil projects
in the world that require oil prices of more than $95 per barrel:

Note that the six
projects that require the highest break-even oil price are all Canadian oil
sands projects, both mining and in-situ. At this point in time, one has
to wonder if these high-cost options will be shelved until the price of oil
retraces its decline.

From the same report by
Carbon Tracker, we find these interesting graphics which show the proportions
of high cost potential production for seven major oil companies:

In the worst case
situation, Conoco Phillips has a portfolio containing potential projects that
require an oil price of at least $75 per barrel and 36 percent require a price
of at least $95 per barrel. In the case of Shell which has the largest
potential production portfolio, 45 percent of their potential projects require
a market price of $75 per barrel and 30 percent require at least $95 per
barrel.

Let's now look at
a graph from a monthly commodity report from Scotiabank back in February 2014
which shows the full cycle break-even costs (including a 9 percent after tax
return on investment) for selected production regions in North America:

The graph shows us that
the weighted average of all breakeven costs for all projects is between $67 and
$68 per barrel. Among the fifty projects examined, Saskatchewan's Bakken
resource play has the lowest break-even costs at $44.30 per barrel. On
the other hand, you'll note that the costs for new oil sands mining and
upgrading projects is $100 per barrel, well above the break-even costs for
existing oil sands production which comes in at between $60 and $65 per barrel.
SAGD (steam-assisted gravity drainage) projects are quite competitive
with a break-even cost of $63.50 per barrel. This accounts for 1.08
million barrels per day of Canada's oil production or 46 percent of Alberta's
oil sands output. It is interesting to see that the break-even costs of
the U.S. Baked and Permian Basin shale oil production is quite high by
comparison to the oil sands, coming in at $65 to $73 per barrel and $73 to $89
per barrel respectively.

Fortunately, many oil
companies use a system of options which insure their production against price
volatility. Unfortunately, all of these come at a cost and as natural gas
producers found out, they only shield production for a finite period of time.
As well, in the past, some companies have found themselves on the losing
end of the bet when prices unexpectedly changed, leaving them having to declare
very significant mark-to-market losses on their positions.

In closing, here is an
interesting graph from Natixis showing U.S. oil production, consumption and
imports since 2002:

Given the very steep
production declines on shale oil producers, unless oil companies are willing to
continue to stay on the production treadmill by drilling oil shale resource
plays at the current lower price level that we're experiencing, we could
quickly find that the purple production line falls back to its pre-2011 level,
putting upward pressure on the price of oil once again....unless, of course, there is another recession!

1 comment:

Well done! Please note this might become very destabilizing to the world economy when coupled with other forces like the increasingly wild currency markets. The article below delves in to the risk of contagion from both the euro and yen continuing to lose value.http://brucewilds.blogspot.com/2014/09/caution-alert-currencies-may-get-wild.html

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About Me

I have been an avid follower of the world's political and economic scene since the great gold rush of 1979 - 1980 when it seemed that the world's economic system was on the verge of collapse. I am most concerned about the mounting level of government debt and the lack of political will to solve the problem. Actions need to be taken sooner rather than later when demographic issues will make solutions far more difficult. As a geoscientist, I am also concerned about the world's energy future; as we reach peak cheap oil, we need to find viable long-term solutions to what will ultimately become a supply-demand imbalance.